One of the biggest investment decisions you’ll make is your asset allocation. This is how much of each investment type stocks, bonds etc. you’ll hold in your portfolio at any given time. One of the most basic principles of investing is to gradually reduce your risk as you get older.
What Is the 100 Minus Age Rule?
A commonly cited rule of thumb has helped simplify asset allocation. This rule says you should take 100 and subtract your age. The result is the percentage of your assets to allocate to stocks. Using this rule, at age 30 you would have a 70% allocation to stocks; by age 60, you would have reduced your allocation to 40%. This is referred to as a “declining equity glide path.” With each passing year you would decrease your allocation to stocks, reducing your investment portfolio’s volatility and risk level.
Issues with the Rule?
- This rule assumes that financial planning is the same for everybody. Investing decisions should be based on your financial goals, current assets, future income potential, and additional factors. What if you plan to retire early say at the age of 50? You will require your money sooner, but since due to the 100 minus age rule, 50 percent of your wealth will be invested in equities where the risk and return varies making your early retirement plan unsafe.
- Risk taking ability vary for individuals. At the age of 30, your risk-taking capacity is high, and you can afford to spend a significant chunk of your wealth in equities. But what if your income does not allow you to take risks even when you are 30? You cannot rely on equities solely based on your age.
- The life expectancy vary in many developed countries and has steadily risen. So, they have more time to grow their money and recover from a dip.
4. Inconsistent results in reference to market fluctuations: it is not possible to predict or foresee future market performances at the time of an individual’s retirement. Thus, it would be wise to chalk out a sound allocation method that sails through the crests and troughs of the stock market.
Is there a better way to plan?
A more practical alternative is to focus on goals and accordingly decide your asset allocation. You can use a static allocation approach, such as 60% stock and 40% bonds with annual rebalancing based on your Risk appetite. Apart from the risk appetite important factor which should determine your investments is your time horizon. Investment in equities requires a longer time frame. So if you are willing to stay invested for a shorter time frame, debt funds should be your pick.